Knowledge@Wharton

Oprah Winfrey. Michael Jordan. Richard Grasso.

What do these three have in common? All have been paid astounding amounts of money, yet only one has been openly criticized and ridiculed because of it.

Grasso, the former chairman of the New York Stock Exchange, is only the latest among numerous executives pilloried for their excessive compensation. Certainly many of the CEOs under fire – Kenneth Lay of Enron, Dennis Kozlowski of Tyco and Bernie Ebbers of WorldCom are just a few examples – led their companies in ways that were allegedly inimical to the interests of a wide spectrum of constituents, including shareholders, employees and customers. It is hardly surprising that they are in the hot seat.

But Grasso, who only recently came under investigation for possible influence trading during his NYSE tenure, has been derided mainly for persuading his board of directors that he was worth all the money – $187.5 million in deferred compensation – they heaped on him. Certainly Jack Welch, the former chairman of General Electric Co., created an enormous amount of shareholder value during this tenure, but even he is being criticized these days for excessive greed.

Actors, athletes and executives are among the most populous inhabitants of the rarified atmosphere of multimillion dollar incomes. Why is it, then, that corporate executives are coming under fire for excessive pay when athletes like Michael Jordan and entertainers like Oprah Winfrey seem to stir no such feelings of resentment? Indeed, Winfrey is widely beloved by millions of people, many of whom are women with lower-than-average incomes, and Jordan is respected and admired by millions more, many of whom are men with lower-than-average incomes.

‘I Could Do That’

Part of the answer, suggest some experts, is the nature of their different jobs. Athletes and entertainers produce something that is clearly evident to their fans. Stars, for example, have a talent and presence that millions flock to the theaters to see and athletes turn in amazing performances on the basketball court or the football field that fans know they couldn’t in their wildest dreams accomplish. CEOs, in contrast, often have a hard time demonstrating exactly what they bring to the party.

“People get a direct benefit from what entertainers provide,” says Peter Fader, a professor of marketing at Wharton. “Life is better because of entertainers, and there’s a genuine admiration for the special skills that entertainers have. People look at them and say, ‘Gee, I wish I were like that person, I wish I had their talent.’ But when people look at managers, they tend to say, ‘I could do that.’”

Fader adds that entertainers and athletes also exude a bigger-than-life aura that leads fans to forgive – even applaud – what among regular people, including executives, would seem pretentious or even outrageous. “It’s interesting to notice how regular people put things in different contexts. An actress is expected to emerge from a limousine, but when an executive gets out of one, it’s seen as something excessive.”

Wharton accounting Professor David F. Larcker, an expert in executive compensation, says it is common for people trying to explain the high pay of CEOs to benchmark executive salaries to the compensation paid actors and athletes. But he argues that the markets for actors, athletes and executives are different from one another and don’t necessarily work efficiently enough to make comparisons worthwhile or even to assure that within any one of those groups the correct pay levels are being set.

Of the three, Larcker says entertainment appears to be the most transparent and efficient. “With entertainers we can actually see what’s being produced. There’s a market where Julia Roberts or George Clooney are paid $10 million to $20 million per film. But it’s a bare knuckle industry. Kevin Costner was very, very hot at one point, in the $5 million to $10 million range for a movie. But now he’s dropped off the scene and is having a hard time getting work. That market works. If you’re not bringing in the box office, you’re toast.”

Professional athletes also expose their performance to public judgment, but they are paid directly by the team owner who isn’t always in the game to make money. “Sometimes it’s more or less a hobby for whoever owns the team, usually wealthy individuals,” Larcker says. “They may decide they want a certain person with a certain talent and they’re willing to pay large sums of money for that person. The issue is, does that labor market actually work? It’s highly debatable. You do see the value of franchises going up over time, so there must be some economic benefits to the owners, but the financials are all rolled up and it’s hard to know how much money people make from owning the franchise.”

Kenneth Shropshire, chairperson of Wharton’s legal studies department and a former sports agent, counters that athletes don’t escape the wrath of fans if they serve up disappointing performances. For one thing, everyone knows how much the players are paid and that becomes part of the fans’ assessment of how good a player really is. The statistical nature of most professional sports also contributes to the scrutiny players get. “Lots of statisticians will publish ‘dollars-per-hit’ or ‘dollars-per-touchdown’ numbers,” he says. And ultimately fans can vote with their ticket dollars on what kind of value the collective talent on a team provides.

A New Best & Worst List

An example of the scrutiny given athletes comes from Forbes magazine’s website, Forbes.com, which each year ranks the performance and pay of major league baseball players. This year it added a feature, “The Best Pitchers for the Money,” that ranked the best and worst pitchers for the buck derived from 2002 salaries and performance. The best pitcher for the buck? Roy Edward Oswalt, a relatively unknown 25-year-old right-hander from Mississippi playing for the Houston Astros with a 34-13 record over three years and a salary of just $500,000. The worst? Colorado Rockies pitcher Mike Hampton, who had a measly seven wins in 2002 and wound up being traded to Atlanta, albeit with a 2003 salary of $12 million.

And, of course, the New York Yankees are in for their share of opprobrium in the wake of their World Series loss at the hands of the Florida Marlins. Much has been made in the series news coverage of the huge discrepancy between the Marlins’ $52 million annual payroll and the Yankees’ payroll, variously estimated at between $157 million and $185 million. More specifically, Florida Marlin’s pitcher Josh Beckett is paid about $1.7 million while Yankees hurler Andy Pettitte earned about $11.5 million in the season just ended.

Wharton marketing professor David Reibstein notes that Yankee’s owner George Steinbrenner, in the aftermath of the Yankee’s loss, was widely quoted threatening to cut some players. Reibstein says athletic salaries are “highly resented” when a player or team doesn’t produce wins, especially in baseball. “Part of the reason is that a lot of people have played baseball and they think it’s something they can do. They will say to themselves ‘I can’t dunk a basketball and I don’t weigh 300 pounds and don’t want somebody who does sitting on me,’ but they have played baseball.”

In addition, fans – conscious of rising prices for tickets and concessions – make a direct correlation between those prices and the rapidly-rising pay levels of the players they pay to see, Reibstein says. “Those salaries are coming out of people’s pockets and they resent it.” In contrast, he says, most people don’t know who the chairman of Procter & Gamble is, don’t know what he’s paid and are unlikely to make any connection whatsoever between his compensation and the price of a tube of Crest toothpaste.

In any case, when it comes to CEO compensation, Larcker worries that the market for executive talent may not be working very well. “As an economist you look at this and say if this is a well-functioning labor market, then people are paid what they’re paid and that’s fine. But is it functioning well? It isn’t a market in which there’s an arm’s length exchange and where there are lots of transactions. In many cases, you have friends hiring friends.”

Certainly more and more people are asking if the CEOs running companies where these people work, or in which they hold stock, are worth what they are being paid – and coming to the conclusion that they aren’t.

“I think most people believe that for the big companies, these guys are paid excessive amounts relative to the value they are creating,” Larcker says, “but it’s hard to make a broad statement. You have guys like Bill Gates or Michael Dell who have done huge things from scratch and most people would agree they deserve to be paid a lot. But there are many executives [where] you can’t really nail down what they have done.”

Weill vs. Grasso

The contrast between executives who have created palpable shareholder value over the years and those who have been paid large sums with little to show for it can be seen in the differing perceptions of Sanford Weill, the recently retired CEO of Citigroup, and Richard Grasso, who resigned amid disclosures that he had been awarded more than $187.5 million in deferred compensation. Both came up from the streets of New York and started their careers as Wall Street clerks, Weill at Bear Stearns and Grasso at the New York Stock Exchange. Weill used his clerkship to launch, then lose, one financial empire, only to come back and create a second one that resulted in the creation of Citigroup. Grasso, on the other hand, remained at the Big Board, learning the intricacies of the exchange and making the contacts that would eventually propel him to its chairmanship.

In the past year Weill has come under investigation for his personal intervention to get the children of star telecom analyst Jack Grubman into a prestigious New York preschool even as Grubman was changing his view of AT&T in an apparent bid to win investment banking business from the company. Weill was exonerated, but forbidden by regulators from speaking directly to his company’s securities analysts unless in the presence of a third party. Grasso, meanwhile, had presided over the New York Stock Exchange and garnered accolades for getting trading started again quickly after the Sept. 11, 2001, terrorist attack on the World Trade Center.

Today, despite his retirement as chief executive officer of Citigroup, Weill remains a powerful voice in the company, continuing to serve as chairman and enjoying the enormous wealth he accumulated along with shareholders who invested in his companies. He is regarded as one of the nation’s great philanthropists, having donated millions of dollars to Carnegie Hall and the Cornell Medical School. Grasso, on the other hand, resigned in ignominy after his massive pay package was disclosed, a package given him by a board of directors that consisted of the CEOs of many companies that the Big Board was charged with regulating. The exchange now has new leadership, a smaller board and greater separation between its trading and regulatory functions.

“Sandy Weill has his faults, but there’s never been any question that creating shareholder value was and is his lifelong quest,” says Monica Langley, a Wall Street Journal reporter who recently published a biography of Weill’s rollicking career called, Tearing Down the Walls: How Sandy Weill Fought His Way to the Top of the Financial World …. and Then nearly Lost It All. “Anyone who has been with him since the early days or invested in his companies from the start is very wealthy. He’s been very well paid, but mostly in line with Citigroup’s shareholders.”

Grasso, in contrast, created no easily discernible value in his career and took few risks. “Sure, the New York Stock Exchange is a critical part of the economy, but what has this guy done to increase the value of it?” asks Larcker. “It’s hard to imagine that Grasso, who is fundamentally a regulator, would be paid as much as investment bankers who have billions of dollars at risk around the world.”

Much of Grasso’s compensation was deferred and that’s another area that is stirring ire among shareholders, employees and other important corporate constituencies. Jack Welch retired from GE among accolades and was widely regarded as one of the greatest CEOs of all time. But then, as part of an acrimonious divorce battle, his lavish retirement compensation and benefits were disclosed and suddenly he was tumbling off his high pedestal. The problem, Larcker says, is that while direct annual compensation is pretty well disclosed, deferred compensation often is murky and only rarely comes to light.

“My view is that if you have done well, you deserve to make the big bucks,” he says. “But when you’re gone, you’re gone. The thing that angers people is the kind of stealth compensation we’re seeing. I don’t think people begrudge Welch all the money he made as CEO. But here’s a guy who amassed unbelievable sums of money and shareholders find they are still . . . paying for his apartment, his travel and even his tickets to Knicks games.”

Because of accounting scandals like Enron, WorldCom and Tyco, the audit committees of many boards of directors are under pressure to do a better job. Larcker thinks executive pay issues are going to focus similar attention soon on compensation committees.

“People have been hammering away on audit committees, but the next one on the chopping block will be compensation committees,” he says. “Too often they get their consultant to do a survey of pay levels at other companies so they will be somewhere in the ballpark. That’s a pretty feeble justification. It’s time for compensation committees to justify more rigorously why they pay executives what they do.”

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